AOL’s “Little Revenue Dance” and the SEC…

May 19, 2008

A short time ago, the SEC filed civil fraud charges against 8 former AOL executives, including two former CFOs. The 8 are charged with overstating AOL’s ad revenues by over $1 billion, which given the time frame this was supposedly happening — from 2000 to 2002 — seems like quite a feat. Here’s a snippet from the release:

from at least mid-2000 to mid-2002, John Michael Kelly, former Chief Financial Officer of AOL Time Warner; Steven E. Rindner, former senior executive in the company’s Business Affairs unit; Joseph A. Ripp, former Chief Financial Officer of the company’s AOL division; and Mark Wovsaniker, former head of Accounting Policy, engineered, oversaw, and executed fraudulent round-trip transactions in which AOL Time Warner effectively funded its own advertising revenue by giving purchasers the money to buy online advertising that they did not want or need.

In addition to money, the complaint seeks to bar the four executives named above from serving as officers or directors of publicly traded companies. Four additional AOL executives — David M. Colburn, Eric L. Keller, James F. MacGuidwin, and Jay B. Rappaport — have agreed to settle with the SEC without admitting or denying the complaint. Colburn, the former head of the Business Affairs unit, will pay nearly $4 million in disgorgement and interest, according to the filing. Both Colburn and MacGuidwin, the former Controller, have also agreed not to serve as directors or officers of public companies for 10 years and 7 years respectively.

Of the two complaints, the 56 page Kelly et al complaint makes for much more interesting reading and can be found here. As the complaint details, Time Warner, which merged with AOL in January 2001 in what has to be one of the worst mergers ever, eventually wound up restating over $1 billion from these various “round-trip” deals where AOL handed over money so that various advertisers could pay for ads on AOL. The AOL name, once so prominently displayed, has been virtually vanquished and the company is once again known as Time Warner (TWX). Here’s a snip from the actual complaint, which describes the deals as “BA Specials” — apparently the term that was used inside the company:

“In mid-2000, with the Time Warner merger pending, AOL faced a growing crisis with regard to its advertising revenue as the market for online advertising began shrinking.

The complaint goes on to talk about “sham transactions” that various executives were involved in, including a deal with Sun Microsystems (JAVA) which supplied equipment to AOL. According to the complaint, AOL agreed to buy $250 million in equipment from Sun in exchange for Sun giving AOL a 15% discount, which in an email was described as “accounting help”, but which AOL decided to count as advertising revenue. According to the complaint, that transaction was used as a model for future transactions with Veritas (now owned by Symantec), Hewlett-Packard (HPQ), and Telefonica (TEF). The section on Telefonica includes a transcript of several AOL employees talking about “doing a little revenue dance”, which sounds a wee bit scary and definitely not something you’d want to see on “Dancing with the Stars”.

Fast forward to today and there’s a new round of media consolidation deals largely based on online advertising revenue. Hopefully, the various metrics out there for measuring ad revenue are a bit more sophisticated than what enabled these AOL execs to structure these round-trip deals.

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